The new carbon welfare

Who should be compensated for the government’s emissions trading scheme or “carbon tax"? And how generous should the compensation be?

The two candidates for assistance with the most popular support are low-income households and emissions-intensive trade-exposed industries.

The case for assisting lower-income households is obvious, although the appropriate extent of the compensation might not be.

The Rudd government proposed to overcompensate these households, but the Gillard government’s independent adviser,
Ross Garnaut
, says “full compensation and not overcompensation should be the objective". There are, however, two arguments for what might be viewed as overcompensation of those in the lower part of the income scale.

Fully offsetting the impact of the average impact of the carbon tax on real after-tax incomes would leave average consumers of carbon emissions no worse off. But above-average consumers would still be worse off.

The second argument relates to savings accumulated before the introduction of the carbon tax. The increase in the price level as a result of the tax reduces the real value of savings.

The case for compensating trade-exposed industries is that most of their competitors are not yet subject to a carbon tax. In the absence of assistance, our trade-exposed emitters, such as the aluminium industry, will be put at a competitive disadvantage. The result could be a shift of production to non-taxing countries, which would damage the Australian economy without achieving any reduction in global emissions. That still leaves the question of how generous the compensation should be.

If we imposed a carbon tax with no exemption for trade-exposed industries, the Australian dollar would depreciate to offset the loss of competitiveness of our export and import-competing industries.

Related Quotes

Company Profile

In that case, trade-exposed industries with average emission intensity would suffer no loss of competitiveness. Those with below-average emission intensity would be better off, and only those with above-average intensity would be worse off. This suggests that assistance should be confined to the most emission intensive industries, and should be given only to the extent that they have not been compensated already by the Australian dollar.

Garnaut argues that high-emitting exporters should be assisted only to maintain the levels of output likely when the rest of the world is also taxing emissions. More generous assistance would encourage investment in the industries that is unsustainable in the long run.

Of course the list of those seeking assistance extends well beyond the producers of globally traded goods and services. For example, the electricity generators claim they need assistance to guarantee the energy supply.

The generators are in the bit of the economy that is not directly exposed to international trade – what economists call the non-traded sector. This is a key distinction because most industries in the non-traded sector are able to pass at least some of the cost of the carbon tax on to their customers. Their prices are determined not on global markets, but by supply and demand in Australia.

However, the opportunity for non-traded industries to pass on the tax varies with the competition they face. A brown-coal electricity generator would have trouble passing on the cost of the tax because its customers can switch to cheaper black-coal electricity. It therefore has something in common with the aluminium producer.

Should the brown-coal generator be compensated for that reason? Most economists would say no. While both producers would be forced to absorb the tax, there is one key difference.

The aim of the exercise is to reduce global greenhouse emissions. Shutting down the aluminium industry will not cut global emissions if the production simply moves overseas. But shutting down the brown-coal electricity generation in Australia probably will reduce global emissions.

Of course, the owners of the brown-coal electricity generator might also say they have a claim for compensation based on equity. They invested in the industry in good faith but, on the strength of new scientific information, the government has changed the rules of the game.

However, exactly the same argument applied to the owners of the tobacco companies when governments began discouraging the sale of cigarettes. They weren’t compensated, and the truth is that governments generally do not compensate industries for the cost of correcting market failures.

The emergence of new information can be good or bad for investors. It’s just the luck of the free-enterprise draw.